Global easy money policy likely to continue

The textbook exposition of monetary policy whereby central banks pursue a countercyclical stance via tinkering a key monetary policy rate seems to be going out of fashion for some time. If one forgets Japan’s solitary case, then debunking the traditional monetary policy could perhaps be traced during the heyday of the global financial crisis in the developed world when monetary policy rates hit their zero lower bound.

Faced with the helplessness of traditional monetary policy, central banks in the advanced countries initiated what is now known as the “unconventional monetary policy”, with two distinct constituents, — (a) quantitative easing (QE), and (b) forward guidance.

The size of the US Fed balance sheet went up from around $890 billion in 2007 to $2.2 trillion in 2008 and has continued rising since then. After reaching a high of $4.5 trillion by the end of 2017, the Fed started the withdrawal process from its spree of asset purchase. It was expected that the monetary policy in the advanced countries is about to be back to the path of Greenspan’s baby steps of tinkering with the policy rate by 25 basis points each time. But the course of history turned out to be otherwise.

Covid and monetary policy

If one fast-forwards to the current pandemic, the policies introduced during the global financial crisis are very much alive and kicking.

Faced with the unprecedented impact of the pandemic, apart from adopting rate cuts (wherever possible) and providing forward guidance, central banks in the advanced countries adopted three distinct sets of policies: (a) continuation of the policy of asset purchase; (b) adoption of policies towards liquidity provision and credit support for different entities; and (c) regulatory forbearance (like a countercyclical capital buffer). These seem to have worked well in giving a fillip to demand via providing liquidity in various economies.

Current dilemmas

But how long can these policies continue? In the current context, various newer challenges have appeared on the horizon.

One major problem is coming from the supply side. This is due to a combination of supply-chain disruptions, a massive increase in commodity prices (like metals and food), and a sudden spiralling of energy prices across the globe. These factors have led to a loss of momentum to the nascent recovery.

In its October 2021 World Economic Outlook, the IMF has lowered its growth estimates for the global economy for 2021 and 2022 due to these disruptions faced by higher-income countries. These supply-side factors have also complicated the inflation scenario in most developed countries.

It is expected that the massive economic expansion undertaken during the last two years might lead to a demand-pull inflation in some future date. Now, with the cost-push pressures added to this, some economists like Larry Summers argue that the danger of a spiralling inflation in the near future is imminent.

Doves dominate

However, most central banks seem to have adopted a more dovish approach towards the threat of higher inflation. Though most developed and some developing countries are already experiencing high inflation, their central banks are viewing this inflation as transitory, and they expect the price pressure to moderate in the near future. For example, Bank of Japan, and the European Central Bank indicated last week that they are not spooked by the higher inflation numbers, and they will continue with their accommodative monetary policies.

Similarly, the Bank of England, contrary to expectations, did not raise its interest rates. The US Fed has only committed to wind down its massive bond-buying stimulus by June 2022. While the Fed is expecting the inflation to abate, Fed Chairman Jerome Powell has recently acknowledged the possible threat of higher inflation due to supply-side problems. He says: “The risks are clearly now to longer and more-persistent bottlenecks, and thus to higher inflation”. But, so far, there has been no announcement of an interest rate hike by the US Fed.

The challenges for the central banks are also becoming complex due to confusing signals from job markets. The labour market was supposed to have a lagged but robust recovery due to the strong GDP growth rate numbers in developed countries. But recent data suggests that the job market recovery has been asymmetric and uneven, with the recovery being particularly weak for the youth and lower-skilled workers.

Consequently, despite modest recovery, the overall employment levels around the world have remained below their pre-pandemic level. Given the subdued outlook for growth, and uncertain job market dynamics in the developed countries, a drastic change in the monetary policy stance by their central banks is not likely. Possibly the central banks may slow down their asset purchase programmes, but interest rate hikes are unlikely in the near future. This is understandable as in the present circumstances, the effectiveness of an interest rate hike to stymie a primarily cost-push inflation is questionable.

There is also an argument that the expansionist monetary policy measures by developed nations have fuelled asset price inflation across the world and the central banks should act against this. While this is a genuine concern, at this point it may be worthwhile to explore fiscal measures to address this problem. Given the fragile nature of the current economic growth, a monetary contraction to check asset price inflation may become counterproductive.

Normalisation, a distant dream?

The Fed of St Louis, highlighted three key elements of the normalisation process: increases in short-term market interest rates; reduction in the size of the balance sheet; and transformation of the Fed’s asset holdings to a composition similar to those of pre-Great Recession times.

While the QE might slow down in the near future, it does not appear that the world is otherwise ready to come back to its good old Normal — at least for some more time! Meanwhile, may the “unconventional monetary policy” not become a convention among the central bankers.

Ray is Director of the National Institute of Bank Management, Pune, and Pal is Professor of Economics at IIM, Calcutta. The views expressed are personal.

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